The UK economy takes centre stage and it is time for some honesty

This week has seen some momentous events for the economy of Europe and in particular for its more peripheral members such as Greece and Portugal and maybe Ireland and Spain too. However today is the day when the UK economy is due to take centre stage in the televised debates and many eyes will be on the BBC to see what the leaders of the three main political parties have to say. Tonight does matter as it would appear that the electorate is rather undecided and is still looking for a real leader to emerge. I have mentioned before in my update on the 15th April  that we have had something of a false debate on this subject where none of the main political parties have properly addressed the challenges facing our economy. This is always an important issue but as we struggle to recover from the severe recession of the “credit crunch” and try to avoid any backwash from the current crisis in the Euro it should be the most important issue in the election debate.

Fiscal Policy and “the elephant in the room”

On the 15th April I observed the following

Yesterday Vince Cable the prospective Chancellor for the Liberal Democrats used this evocative phrase to describe the question of the UK fiscal deficit and of course this also has an implied view for the National Debt. However this is an area where all three main political parties have similar flaws in their plans. If you look at the three published manifestoes there is a hole in each of them of a similar size, £30 billion. So in truth none of them are being transparent and honest in their spending pledges. So the answer to the question what are they not telling us? Is in economic terms £30 billion. This is just over 2% of our Gross Domestic Product (GDP). Put another way it is around a quarter of the annual cost of the National Health Service.

Since then we have had little or no further insight from any of the main political parties on what if anything they plan to do. I say if anything because one of the lessons of the crisis surrounding Greece is that Europe’s politicians plainly feel that even such a serious crisis can still be fixed by talk and promises. One cannot dismiss the idea that ours may be doing the same about our fiscal deficit. When Chancellor Merkel of Germany said yesterday that Greece required a “timely” response ,which regular readers will be aware is in fact the opposite of the approach she has adopted as she has been desperate to delay any aid package until after the May 9th elections in North Rhine Westphalia, I was reminded of the song which starts “Reality was once a friend of mine……”

What is the situation?

Our fiscal deficit for the last year was £163 billion which is 11.6% of our economic output (Gross Domestic Product or GDP). A major component of this high level of borrowing was the impact of the recession we have just been through but it is also true that the public finances had deteriorated because of the decision by the current government to increase public spending from 2002 onwards. This deficit is likely to prove persistent over the next few years and current plans still involve us having a fiscal deficit at the end of them in 2018 when for example we will still be borrowing 6% of our economic output. So we are in danger of pushing our national debt and the annual cost of financing it onto an expensive unstable path.

All of the three main parties accept this reality it is just that they have no concrete policies to deal with it. The main problem is public spending plans or rather the lack of them and I am grateful to the Institute of Fiscal Studies for these numbers for the period up to 2014/15.

 The worst offender is the Liberal Democrats who have not explained where they will find £79 billion of spending cuts which is 5.4% of national income.The Conservatives plan spending cuts but have not explained where they will find £71 billion of them which is 4.8% of national income. Labour plan spending cuts but have not explained. Labour have £59 billion of spending cuts which they have not explained which is 4.1% of national income.

Conclusion and Comment

There are slight differences between the exact composition of these numbers so they are not be taken too literally but as a group they are very revealing. You see the cuts required are of a scale not seen since the IMF was called into the UK in 1976 and depending how things actually turn out maybe not even then. The scale is enormous and I feel that the reason politicians of all parties are not telling us is that they simply do not know. To that extent all of the manifestoes produced so far are a misrepresentation of our position and this does have a slight echo of what happened in the last Greek election. I do not think we are in the same position as our national debt is lower in comparative terms but this sort of political thinking was one of the contributors to Greece’s current mess and accordingly it would be unwise to repeat it.

I have previously explained the true position of the Conservatives plans for what they call the “jobs tax” for today I wish to just point out the scale of it £6 billion a year and then for you to compare it with our deficit of £163 billion. Our political debate has centred on what is in the main scheme of things a relative sideshow.

Some honesty is needed and I hope that this question will be asked tonight, When will you tell us the truth about our fiscal deficit?


We are in a position where our inflation rate is above target but there is almost no debate about it at all. One possible reason for this is that many members of my profession subscribe to an “output gap” theory and seem to feel that because it predicts that at this time we should not have inflation then in fact we do not ( “Reality was once a friend of mine” again). Those who do not follow this subject closely may be unaware that our inflation target was changed in 2002 to what I consider to be a softer target so that our actual position is in fact worse than shown by the current target. I discussed this subject on the 20th April.

Our Old Target RPIX

RPIX inflation – the all items RPI excluding mortgage interest payments – was 4.8 per cent in March, up from 4.2 per cent in February. Perhaps the most revealing of all the numbers as this was our previous inflation target and was set at 2.5% so it is some 2.3% over its target.

I am not one of those who sees inflation around every corner but I am one of those who has concerns that this phase has the risk that it may persist for longer than the official view of a “blip”. You see the Monetary Policy Committee when it sets interest rates looks 18 months or two years forward. So if we go two years forward our official forecasts are for a high growth rate of 3% per annum and we have inflation in our system before we get this acceleration in growth. Other central banks such as the ECB are already worrying about inflation in the future from much lower inflation levels than ours implying that they would already be responding.

The Monetary Policy Committee (MPC) of the Bank of England

This body was set up by the current administration to set UK interest rates and the point of it was that it was supposed to be independent and therefore not subject to political interference. This was successful for the first stage of its existence but the advent of Quantitative Easing means that it can no longer claim to be independent of government policy in my view. You see this policy required the permission of the Chancellor of the Exchequer and tied monetary policy to an extent with fiscal policy.

This subject has had no debate at all during the election but my question for tonight would be twofold on this subject

1. How do you plan to make the MPC independent again?

2. What reforms do you intend to make to the MPC to help prevent it making more policy errors in future?

Quantitative Easing

This was a policy undertaken by the Bank of England where it purchased some £200 billion of our own government debt starting in March 2009 and ending in February this year.It’s stated policy objective at the time was that such a policy was required to bring inflation back to its targeted level. You can see from my section on inflation above what it actually helped lead too. Since then the Monetary Policy Committee has changed its view on what the policy was supposed to achieve more than a few times. If you read my articles on this subject you will see my explanation of why i feel the policy was a mistake and certainly should not be extended in any way. But today I wish to firstly point out the lack of any debate on this important subject in our election and explain the implications of what has already happened for the UK’s economic future. I explained my thoughts on the 1st of April.

QE was a policy mistake which has implications going forward. In effect the Monetary Policy Committee acted like an organisation in a state of panic. Perhaps the first tranche can be forgiven as a mistake in extraordinary circumstances but to continue with it was a clear error in my view. As I have stated above there was evidence prior to the event of the likely consequences of it.

Going forward there are two other problems. The first is that one day we will have to get these bonds off the books of the Bank of England. The other is that the asset bubbles which it has helped to create are reinforcing some of the problems that created the credit crunch. Whilst it is painful we do need an adjustment in areas such as residential property and I see no reason at all why we should protect wealth created by the speculation and bubbles of the pre credit crunch era. If you think about it doing such a thing is likely to slow structural reform for our economy and we badly need structural reform in my view.

So a policy which was supposed to boost economic growth may end up contributing to medium/long-term growth actually being lower than otherwise as its effects filter out. And it makes us more vulnerable to future economic shocks.

If one looks at a Marxist type of analysis of this policy one might conclude that it looks like a way of protecting an already wealthy elite who are likely to be asset rich which is wearing the clothes of claiming that it protects everyone by suggesting that all falls in asset prices are bad….

House Prices

A reinforcing number for my arguments above has been issued this morning by the Nationwide Building Society. According to the Nationwide house prices have risen over the last year by 10.5%. Now let us look at our economy, we have high and possibly rising unemployment, real wages are falling,and credit is still restricted and constrained. Then so far in the house price recovery we have had fewer actual transactions than normal. This to my mind is a “bubble” and leads to another question for tonight.

What would you do about the current house price bubble and how much do you think official policy has contributed to it?

Let me make it clear that I do not wish for home owners to lose money but that having gone through a deep recession it is to say the least curious that we appear to have rising house prices and from the point of view of prospective buyers they must now be even more expensive than they were in 2007. It may even be true that in the wealthier areas of London prices exceed 2007 levels…


The standard of debate on economic matters in the UK election so far has at best been poor. This is not unprecedented in our history as 1992 and Harold Wilsons first administration come to mind. However I have outlined what I feel are important issues and hope that someone in the audience tonight will be thinking along similar lines or will read them today.

I was asked yesterday to relate what is happening in Greece to what is happening in the UK and hope that I have left you with the opinion that we are not Greece but we do have serious issues many of which are not getting much of a public airing. We need to address them to try to keep us out of the financial whirlwind which is surrounding Greece as if we dither and misrepresent as our politicians are doing right now then we could get sucked into trouble. Perhaps as a final question for tonight someone might like to ask a (slightly mischievous) question, do you think the UK should join the Euro as it presently stands? You see over the next few years whatever your stance on the Euro (and by this I mean for or against) exchange rate flexibility looks like it could be a valuable weapon.

I am now off to look at some genuinely scary rumours coming out of Greece that for example a rise in Value Added Tax  to 25% is bein proposed…


14 thoughts on “The UK economy takes centre stage and it is time for some honesty

  1. Shaun, if I may I would point out that you seem to have neglected the issue of all the amassing off-balance sheet debt in these considerations. What needs urgently to be admitted by the government now is what the total government debts, including PFI and all other off-balance sheet debts is. Only by appreciating the sheer scale now of the total government debt can the big picture be properly comprehended. We have to remember that all of this debt has to be serviced in one way or another?

    In addition, I feel that you are being too soft in your summary of the dire performance of the MPC. It has been a disaster as measured by its continuous failure to achieve its one sole remit. This is largely because its constitution was severely flawed and its supposed independence was a deliberate sham; then also its members were hand-picked by Brown and this ensured that they all had a pronounced left-wing bias. For the concept of the MPC to work and for it to be truly independent it or a replacement for it needs to be reconstituted with a remit which ensures its autonomy, and its members need to be recruited independently on a normal competence basis rather than a political basis, to ensure a future absence of political bias.

    • Hi Drf
      I agree that PFI is a problem going forward and could easily have been included in my analysis. I sit down and think of the issues and then write on them. Being human I do sometimes miss things out I intend to put in or maybe should have put in. Earlier in the week I had five points for explaining Portugal’s economic problems and somehow managed to type only 4!

      As to the MPC as I have written today it is no longer independent and it has made policy mistakes and I believe changes need to be made…

    • Shaun,

      Sovereign debt and the off-balance sheet debt has been mentioned as a general problem for almost every developed economy. You might have seen Dylan Grice’s analysis:
      (I understand that Mr. Grice is not a disinterested observer, but who is)

      The overall sovereign debt is now recognized as a problem essentially openly — from El-Erian’s statements to the Economist. Add to this the off-balance sheet issues along with the aging population, and… how might this be resolved?
      What I am trying to say is that this is not just about Greece or the UK, but concerns basically everyone. Does this change the dynamics for individual countries?
      My uneducated expectation is that there is a very painful belt-tightening coming for everyone — and I don’t want to speculate to what it might lead. Any thoughts?


  2. The broad outline of today’s blog would seem to be the leaders debates and in particular the content. I think these debates have prejudiced our democratic system in as much as a lot of people I talk to think they are about to elect a leader in some sort of Presidential election, which we blatantly aren’t, we elect individual MPs. These glitzy American style TV offerings make the three party leaders into, at best, PR men equipped with the usual spin, hype and sound bites which they deem necessary. It would therefore seem strange if we expect to hear anything of real substance. We have been preconditioned into having the attention span of a gnat which only allows transient politicians to parade their wares! Its not just fiscal policy which needs structural change………

    • Since in my opinion the UK economy, whilst being miles ahead in my mind in terms of structure and “hardiness”, data-wise is not too far behind from the absolute mess the Greek economy currently is, I thought I’d provide an update on the proposed measures to be taken here.

      They are not official (the full scale of measures will be officially confirmed by Sunday I believe), but they are more or less the following:

      Abolition of the “13th and 14th” salary in the public sector, for a net income reduction of at least 14.5 %.

      Abolition of the same provisions for all pensioners (who are already on humiliating pensions in very many cases).

      Salary freeze for the public sector until 2013.

      Conversion of the ’13th and 14th salary’ in the public sector to an (optional, I suppose) performance bonus stipend, by law.

      Abolition of union negotiations for yearly increases or adjustments to their working terms and conditions, with the employer unions.

      Abolition of mediation by independent ombudsmen to resolve stalled negotiations between employee unions and employer organizations.

      Increase of VAT by 2-4%, to 23 or 25%.

      Increase of the allowed redundancy percentage per month from 2% to 4% (in private sector businesses).

      Decrease of compensation owed to the employee following redundancy by corporate decision / responsibility.


      These may be rumours, to a point, but this information came out following a PM meeting with heads of employee / worker unions as well as employer / trade unions, so although we do not know the specifics, we’ll find out pretty soon.

      It goes without saying that if some of these measures are true (such as yearly reduction of 15% in PENSIONS across the board), I expect riots to take place one way or another. The minimum pension in certain cases is 400 or 500 EUR per month, and a pensioner living alone usually cannot live with that.

      Considering that certain benefits here are already too low (unemployment benefit? 200-250 EUR / month for 6-12 months depending on the circumstances, nothing more under any circumstances. Youth unemployment benefit for people up to 30 years old unable to find a job? 77 EUR / month for 6 months, et al), I expect riots to take place sooner or later. Emigration suddenly sounds quite tempting to a lot of people, and I know I will arrange it in the next couple of years at most for myself.

      • Correction – “Conversion of the ’13th and 14th salary’ in the public sector to an (optional, I suppose) performance bonus stipend, by law.”

        Private sector, not public sector.

        • Good Afternoon Ioannis

          Thank you for the updates. There is no shortage of rumour here too although it has to compete in the UK media with tonights election debate.

          I would like to wish you and indeed Greece luck as events move forward. When this sort of thing happens I always wonder where did the money go? And I hope for action to be taken against those responsible for the problems, but sadly it rarely ever occurs.

      • Seeing actual numbers from the Greek commenters is most helpful. I am struck that the figures they present for pensions and salaries do not seem to be unreasonably fat or generous, on the contrary they seem somewhat skimpy.

        It sounds like the austerity measures already on or soon to be on the table are surprisingly strong, e.g. an across the board pay cut of 1/7th. Also while an outsider might think of the regulatory environment being sclerotic and inflexible (e.g. the fact that there is a regulatory limit to the rate at which private employers may lay off workers), they are not only proposing to double it to 4% per month, but it really doesn’t take too many months for a whole bunch of 4% cuts in headcount to be pretty deep cuts indeed.

        And further raising a 21% VAT…???!!!! Truly that sounds as ill advised as it does desperate!

        My opinion is coming around to the view that although the Greek government is not proposing draconian measures, they are indeed proposing fairly harsh measures, much harsher than perhaps they are being given credit for. If true and if this is still not enough to eliminate their primary deficit – then just *how* deeply flawed *is* their fiscal state?!?!?

      • In terms of Greek salaries and pensions I think it is important to make a distinction between private sector and public sector employees (the broader public sector, for which there are all kinds of government guarantees). The system is skewed to benefit public sector employees, from using all kinds of salary supplements (which do not count as part of the base salary) to retirement benefits.
        So, a cut of the 13th and 14th salaries is very serious for a private sector employee, but it might affect a state employee much less as supplements contribute much more to their compensation. The government is trying to reduce such supplements but there is plenty of resistance, including legal challenges.
        In terms of how much credit the Greek govenrment deserves, well, they are very reluctant to address corruption and tax evasion and to level the field between the private and public sectors. There are tremendous inequities between private and public sector employment, including the job security the public employees enjoy. And as far as I am aware, there are essentially no performance evaluations in the public sector (yes, you read it right).

        My two drachmas is that the Greek government will have a very hard time balancing the budget, especially when the pensions problem is taken into consideration — similar numbers to Dylan Grice’s were arrived at by the private sector employees union (GSEE), as reported in the Greek press. But the union decided to put their own dismal projections in the drawer and instead confront the government.


  3. DanielC,

    Most of these measures are forced upon the state from the IMF / EU, mind. The thing is that certain “flaws” in the system exist because of the nature of things over here.

    For instance – Currently there is a 2% limit in total workforce that can be fired per month. When a company does want to fire 10% of the workforce, they do it, but it’s done over 5 months. Why? Because if they had no limits at all, they’d be happy to fire 25% in a month if they could get away with it.

    Who would judge them? The courts? The average court case reaches the court after 3-5 years…the company may not even exist by then (provided it was in trouble and / or fired people in the first place).

    I sense that the government has tried to protect employment, and that is why they went with income decrease vs loss of permanent job positions in the public sector.

    That, and the fact that ‘permanency’ is a constitutional right of these employees, interestingly enough legislated in the 1920’s to ban Government B from kicking off the public sector all of the “Government A’s” friendlies.

    By the way, this behaviour with Government A and B (or Labour vs Tories if you like it in UK-style) continues until today – A government changes, the new government puts its own people everywhere, because among others, the “old government people” refuse to properly cooperate with the new government. They are “the enemy”.

    But really – youth unemployment is phenomenal, and we already had a HUGE benefit for that, of 77 EUR / month (!!!). They might as well scrap that entirely…

    Good days are (not) coming for this country, barring a miracle happening and aliens exterminating our debt holders in their entirety 😦

  4. These measures seem all designed to preserve the status quo in terms of structure whilst at the same time punishing work? Obviously time is of essence here but surely it would have been better to take a long hard look at what is and is not absolutely needed for the state to provide and adjust that way?

    It is as if they were designed to be too much to bear,to force a reaction in the streets.

    Ioannis,I do hope this does not lead to any bloodshed.

  5. My post crossed with yours, which so eloquently explained why a restructured public sector is a near impossibility.

  6. Thank you for your blog, it is always very informative. I was very interested on your comments on asset and property prices and am in total agreement with you. Do you think that the reason the government is doing everything it can to keep property prices high is because the banks could get into trouble again if they come down significantly to align with earnings?

    • Hi Paula and wellcome

      You pose several questions in one go I think. If we start with the property market then the rally back to 2007 levels in terms of residential housing disturbs me. I have looked at the indicators such as the ones I have reported on here and on a more personal level I have followed the sale of one near me which I have just discovered was sold for above the offer price aka ” a return to boom time” I think. Commercial property has also rallied strongly. I think in our current circumstances this is unhealthy. For example if you take the view that house prices were too high in 2007 and since then in collective terms we are all poorer then it must be worse now. Measures one might use on the housing market might be GDP (lower) unemployment (higher) and there has been little or no growth in wages, so there is no explanation there.

      Has government policy led to this? Yes I think the effects of lower interest rates and QE amongst others were clear. Was this deliberate? In some respects yes such as lower interest rates but in others no, having argued that the MPC misunderstood the policy effects of QE I logically cannot accuse them of deliberately doing things! What I believe they intended has not worked out. So some of the impact has been unintentional. The MPC are rather bizarrely trying to claim credit for some of these things and might even plead guilty to your question hoping to be found guilty but if you look at what they said at the time I do not believe they did have that explicit intention.

      Has this benefitted the banks? Without a doubt as they are able to report reduced bad debts and higher asset prices. Whilst I am happy that investors in banks are making some money (including the UK taxpayer) I am concerned that the current rally is based on a false dawn in property prices. There is a possible scenario which frightens me the most which goes as follows. The property market boom carries on for a bit the banks look good their share prices rise and some of the UK taxpayer holdings are sold. Politicians congratulate themselves on what appears to them to be a success. Then the property market gets hit again and the banks hit trouble and a new wave of bank investors lose money as the banks go into distress….. So we begin a new crisis with politicians even more out of touch.

      So in conclusion I fear for the recent rally in bank share prices not because I wish for them to fall but because I fear that at least some of it is built on sand.

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